Derivatives exchange of the year: SGX

Strong performance in Singapore Exchange’s derivatives business has helped it to achieve its most profitable year in more than a decade, with net profit rising 8% year-on-year to stand at S$391.1 million for the year ending June 2019.

Underpinning these results is a robust multi-asset framework that seeks to evolve and adapt in line with clients’ needs.

“Our strong performance across the board reflects the combined strengths of our multi-asset business. All-time records in our derivatives volumes and open interest were driven by strong global institutional demand for Asian risk management and investment solutions,” says Michael Syn, the exchange’s former head of derivatives who has recently been appointed to head of equities.

Growth in China was particularly strong, with increased volumes registered across the FTSE China A50, MSCI Taiwan and iron ore derivatives contracts. This helped boost revenue in the equities and commodities business by as much as 21%, according to Syn.

Clients particularly value the level of product servicing that SGX brings to the market, taking the exchange beyond the service that some of its competitors are able to provide in the region and helping it to win market share.

“SGX are reliable and that’s what counts for an exchange,” says the Asian head of one global brokerage firm. “Connectivity has to remain up and the people behind the scenes, that part of the service is excellent. If we have an issue they’ll address it immediately. SGX want to be competitive and they know, if they want to compete with other exchanges for global market share, they have to act accordingly.”

He adds that SGX works better with his brokerage than some other exchanges he has to deal with, treating the relationship more as a partnership that can benefit both sides, which the Asian head really appreciates.

It was this ambition to win market share by adding value to clients that led SGX to team up with Capitalab, a division of brokerage firm BGC, to offer compression services for Nikkei 225 options that it trades. This is the first compression service for listed derivatives in Asia, and only the second globally, after CME Group launched a multilateral compression service for S&P 500 options and E-mini S&P 500 index futures last November.

SGX want to be competitive and they know, if they want to compete with other exchanges for global market share, they have to act accordingly

Head of Asia at a global brokerage firm

“This initiative was directly driven by client feedback,” says Syn. “The pass-through of capital costs for gross notional is higher for long-dated options and this higher cost is exacerbated by the fact that these positions tend to stay on the books for a longer period of time.”

While Capitalab handled much of the quantitative structuring of the compression service, SGX placed itself at the heart of the process and worked diligently with compression participants to make sure that their systems were correctly set up to provide seamless access, and to co-ordinate system tests between market participants and Capitalab.

“Cost-efficient and operationally efficient clearing of compression trades is only possible with SGX’s full participation, because we help the vendor upload the trades on an all-or-nothing basis into our trade registration system and ensure that everything is cleared,” says Syn. “There is significant involvement from SGX’s risk, regulation, operations and technology departments to ensure that all this plumbing works and is available at a non-standard time of the day.”

Longer-dated Nikkei 225 options have become particularly interesting recently, as the trade war between the US and China has forced investors to try to work out on what side of the divide Japan will fall: is their clear political alignment with the US going to be an asset, or will they suffer from any lingering impact of the trade war?

SGX currently has a market share of Nikkei options of between 30% and 35%. Much of this comes from meeting long-dated hedging needs for institutional clients. SGX clears Nikkei futures of up to seven years, and is the only exchange to offer long-dated dividend futures on the Nikkei 225.

“In order to hedge your forward vol and your forward delta there are a handful of basic tools that you need. Forward vega comes from options and forward delta comes from being able to hedge the benefit and the cost of carrying a front month Nikkei future up to five or 10 years,” says Syn.

This is what makes the new SGX compression service so valuable for clients. Capitalab, which did a lot of the quantitative structuring for the service, says that it expects the compression efficiency in SGX Nikkei 225 options to be as high as 50% once the service gains scale.

Our number one business driver is to make sure that we emphasise, again and again to our clients, we are a flight-to-quality market infrastructure

Michael Syn, SGX

SGX has also been working hard on its FlexC FX Futures product, which allows privately negotiated bilateral trades to be cleared as though they were standard currency futures. This allows clients to retain the advantages of trading over-the-counter while allowing them to enjoy the benefits of clearing, such as a reduction in counterparty credit risk.

Although this was introduced to the market in July 2018, it has required a lot of additional work to adapt the existing workflow and systems of clients so that they can derive the maximum benefit of this new offering. Four pilot trades have been successfully executed over the past six months and SGX continues to add new currency pairs to the FlexC suite.

“By introducing FlexC as a futurised NDF, the market can trade these contracts under their own entity names via an exchange-clearing member, offering a more economic solution,” says one derivatives broker in Hong Kong.

With SGX’s continued focus on China, the outlook for the exchange remains positive. SGX’s A50 futures remain among its most popular products and SGX continues to strengthen its commodities franchise to benefit from the opening-up of the market. In December, SGX launched the world’s first 65% iron ore futures contract, which provided a valuable hedging tool for some companies to better manage the increasing volatility in the commodity class. Most iron ore is blended to a 62% purity, which means that most futures contracts protect this amount. but the spread between the different iron ore qualities has become so wide that a 62% proxy is now no longer any good.

“Our number one business driver is to make sure that we emphasise, again and again to our clients, we are a flight-to-quality market infrastructure. In peacetime we do everything necessary to prepare our channels, our capital, our op risk and our product shelf to make sure there’s minimum viable liquidity, connectivity and margin so that when there’s a need for flexibility clients use us more,” says Syn. “That requires planning and a lot of blocking and tackling on a day-to-day basis. But if you track some of the new products that we launch every year, you’ll see we do things in a very systematic way.”